By: Dr. David M. Kohl
The other day at a seminar, a producer had an interesting comment. He stated that our parents and grandparents had to manage cycles in weather, economics, crops and livestock; however, today these cycles seem to be extreme. While I am not in a position to discuss global warming and climate change, there appears to be credence in the extreme cycles pertaining to economics. Both today and in the future, economic peaks and valleys will create unprecedented opportunities, but also the caveat of more opportunities for business and financial failure.
Those in the grain industry have been bestowed economic prosperity and wealth through the great commodity super cycle lasting a decade, far exceeding any previous super cycle in the past century by two and one half times in duration. Those in the livestock and feather business have had a roller coaster ride in the past decade, and now are experiencing cyclical change. Slowing growth in the emerging nations, softening of the ethanol and biofuels mandates, and a less accommodative Federal Reserve that has maintained low interest rates and value of the dollar have taken the economic bloom off grain and row crop sectors. In turn, the livestock and feather industries have been beneficiaries of reduced costs coupled with strong prices that present economic windfalls. These economic roller coaster rides for many sectors of agriculture alter management and financial strategies as one attempts to maintain control of the business.
Top of the Cycle Management
Now is the time to be proactive for those producers who are experiencing the top half of the cycle. Have a profit plan. That is, 60 percent of your profit should be allocated toward first focusing on efficiency and then business growth. One cannot grow your way to profits! That is if you are not efficient in the first place with negative or marginal bottom line, growth will only result in larger losses.
Focus on getting the top half of your balance sheet in stellar condition by maintaining a strong working capital cushion. Working capital is derived by subtracting current liabilities from current assets. Divide this number into either revenue or expenses and seek a level of 33 percent or greater. Farm record data finds that the top 20 percent of managers have over 50 percent, while the bottom 20 percent have less than a 15 percent working capital cushion. Working capital is your short-term equity that can be used to manage operating challenges and opportunities without disrupting normal operations. It is your shock absorber.
In the top half of the cycle, pay down accounts payable, operating lines of credit, and strengthen the relationship with your lender. Do not become complacent. Most businesses make their worst decisions in the best of times. Failure to maintain a close eye on cost of production, marketing and risk management programs and the purchase of nonproductive assets, i.e. killer toys, are mistakes frequently made in the top part of the economic cycle.
Down Part of the Cycle
When the cycle is waning, similar to what is happening in the grain industry, it is a time to intensify management. Know your cost of production overall, but also for specific enterprises to allocate capital, resources, and time to get the biggest bang for the buck. Shed marginal assets that are not fully utilized such as machinery, equipment, marginally productive land, and even human assets. Know your breakeven prices and link these variables to everyday dashboards of production, cost, and a risk management program.
A favorite tool we utilize on our dairy, dairy creamery, hay, and beef operations is variance analysis. That is, compare actual results to projected cash flows. Monitor positive and negative deviations and whether macro events or micro changes in management altered the results. Close monitoring with your advisory team, comprised of your lender, accountant, or consultants, can be another set of eyes to assist you in navigating through the economic white waters of the down part of the cycle.
Economic cycles can be your friend and can allow you to create your future if you are proactive. However, they can be a devastating trap if one is reactive without a plan.
